Coal Company Seeks GILTI Guidance on Overseas Mineral Interests

November 6, 2018

The Honorable David J. Kautter
Assistant Secretary (Tax Policy)
Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, DC 20220

Lafayette G. "Chip" Harter III
Deputy Assistant Secretary (International Tax Affairs)
Department of the Treasury

Douglas L. Poms
International Tax Counsel
Department of the Treasury

The Honorable Charles Rettig
Commissioner
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

William M. Paul
Acting Chief Counsel and Deputy Chief Counsel (Technical)
Internal Revenue Service

Internal Revenue Service
CC:PA:LPD:PR (Reg. 104390-18)
www.regulations.gov

Dear Sirs:

This letter requests clarification regarding the determination of qualified business asset investment (QBAI) with respect to overseas mineral interests for purposes of computing global intangible low-taxed income (GILTI) for U.S. shareholders. Section 951A requires a U.S. shareholder of a CFC to include in income its GILTI in a manner similar to subpart F. GILTI is generally measured as the excess of a shareholder's net tested income from CFCs over a routine return (i.e., a "super-normal return"). For this purpose, the super-normal return is generally the excess of the U.S. shareholder's net CFC tested income for the taxable year over 10 percent of such U.S. shareholder's pro rata share of QBAI of each CFC for such year (less certain interest expense).

The Treasury Department and the Internal Revenue Service issued proposed regulations regarding the determination of GILTI and QBAI on September 13, 2018. The proposed regulations do not specifically address the determination of GILTI and QBAI with respect to mineral interests held overseas.

We respectfully request that two clarifications to the determination of QBAI be provided to ensure that the super-normal return from overseas mining activities is measured appropriately in determining GILTI. First, expenditures paid or incurred with respect to the acquisition and development of a mine or other natural deposit should be treated as QBAI under section 951A. Second, similar to the use of the alternative depreciation system under section 168(g), the basis in a mine or other natural deposit should be determined using cost depletion (rather than percentage depletion) for purposes of determining the adjusted basis of such QBAI.

Origins of GILTI — Focus on intangibles

The GILTI minimum tax in section 951A has its origins in several previous tax reform proposals, including former House Ways and Means Committee Chairman Camp's tax reform bill (the "Camp bill"), the SFC international tax working group report, and the House-passed tax reform bill.

In each case, the expressed concern was to prevent U.S. tax avoidance on foreign super-normal returns attributable to mobile functions, assets and risks. The primary concern was shifting excess returns from intangible property (through migration out of the United States or otherwise) to low-tax or no-tax jurisdictions. Early tax reform proposals attempted to explicitly identify foreign-based intangible property and measure and tax the return from such property.

However, for simplification and ease of administration, the Camp bill shifted to a formulaic basis for differentiating super-normal returns attributable to intangible property from "normal returns on investments in tangible property."¹

A similar approach was adopted by all subsequent versions, including the recently-enacted tax reform bill. As explained by the House Committee report, "the Committee believes that foreign high returns attributable to mobile functions, assets, and risks are best measured as the excess of foreign earnings over a normal equity-holder's return on assets with limited mobility . . ."²

While seeking to "dissuade" companies from shifting earnings to tax-haven jurisdictions, Congress has also recognized that improper design and application of a base erosion minimum tax could "undermin[e] the ability of American companies to compete abroad."³

Recognizing this, the Camp bill and the House-passed tax reform bill both excluded foreign-derived income from commodities from application of their minimum taxes. This exemption appropriately reflected the fact that commodities income is immobile and necessarily is located wherever the source of production is located. Companies like ours must operate where efficient mineral sources can be found. As the House Ways and Means Committee report explained, "profits from the disposition of market-priced commodities generally do not relate to functions, assets, or risks easily relocated within a multinational group. Accordingly, these categories of income generally can be excluded in computing foreign high returns."⁴

GILTI

Section 951A requires a U.S. shareholder of a controlled foreign corporation to currently include in income its GILTI. For this purpose, GILTI is defined as the excess of the U.S. shareholder's aggregate net tested income over a routine return of 10% on its pro-rata share of the QBAI of its CFCs. GILTI does not include effectively connected income, subpart F income, certain foreign oil and gas income, or certain related party payments.

The expressed rationale for adopting the GILTI minimum tax is very similar to the former tax reform proposals, i.e., to prevent base erosion from shifting intangible income to tax havens. According to the Senate Committee Report:

The Committee believes the type of income that is most readily allocated to low- or zero-tax jurisdictions is income derived from intangible property, or intangible income, intangible income is mobile and constitutes a large portion of the foreign-source income earned by U.S. corporations, and significant erosion of the U.S. tax base could result if no base protection measure were adopted in a move to a participation exemption system. At the same time, if intangible income is located in a jurisdiction with a sufficiently high tax rate, the Committee believes there is limited base erosion concern.⁵

The formulaic approach for the GILTI minimum tax is virtually identical to the prior proposals and the rationale is the same. The Senate Committee Report states:

The Committee views the most difficult problem with identifying GILTI as identifying intangible income, and believes that calculating intangible income based on facts and circumstances may be both complicated and administratively difficult. As a result, the provision adopts a formulaic approach to calculating intangible income to make the determination simpler and more administrable. The formula is based on the premise that directly calculating tangible income is simpler than calculating intangible income.⁶

Thus, like the other proposals, the formulaic approach adopted for the GILTI minimum tax was designed to differentiate highly mobile intangible income that can be shifted to tax havens from less mobile income attributable to tangible property.

For unexplained reasons, unlike prior proposals, the GILTI minimum tax does not exempt all foreign-derived commodities income, but rather singles out certain foreign oil and gas income. Unfortunately, in the haste to pass the bill, no adjustments were made to the prior formulaic approach to reflect the fact that commodities income was being added back and subjected to the GILTI minimum tax.

Consequently, without appropriate clarification to its operation, the GILTI minimum tax will have far more onerous effects on commodities income than income from other similar "tangible" sources, even though commodities income is not highly mobile or susceptible to base erosion. Absent clarification, the GILTI minimum tax will apply to normal returns on active commodities income from mining and other productive activities. This will place U.S. companies with foreign mining operations at a distinct disadvantage against foreign competitors in the jurisdictions where the mines are located.

We believe that adjustments to the formula should be made to reflect the unique features of commodities income and limit application of the GILTI minimum tax to the super-normal returns from foreign mineral production, as clearly intended by Congress.

Proposed Clarifications

We respectfully request that Treasury and the Internal Revenue Service provide guidance that would make two clarifications for the determination of the GILTI minimum tax. Congress intended to exempt tangible income from the GILTI, because it "believes that tangible property, and the associated tangible income, are relatively immobile and an indicator of the extent to which a CFC has active business operations and presence in any particular jurisdiction."⁷ The requested changes are consistent with the expressed legislative intent to exempt all tangible income from the GILTI.

First, we believe that all expenditures paid or incurred with respect to the acquisition, exploration and development of a mine or other natural deposit should be treated as QBAI for purposes of computing the "net deemed tangible income return" under section 951A. The return on these investments should be treated as a normal return similar to the treatment of the return on tangible depreciable property. These expenditures are capital in nature and are incurred in connection with active business operations necessarily conducted in the foreign jurisdiction. The income associated with such expenditures, by definition, is highly immobile as it is tied to production where the minerals are found.

Exploration costs include expenditures paid or incurred for the purpose of ascertaining the existence, location, extent or quality of any mineral deposit before the beginning of the development stage. These costs include, but are not limited to:

Development costs are primarily incurred to obtain accessibility to the mineral deposit and commence production. These costs include, but are not limited to:

Section 951 A(d)(1)(B) provides that property taken into account as QBAI must be "of a type with respect to which a deduction is allowed under section 167" (emphasis added). Exploration and development costs for mining operations are strikingly similar to the types of costs that are incurred with respect to various types of self-constructed tangible personal and real depreciable property (including many types of property for the production, transmission or distribution of energy). Costs for depreciable property are capitalized into the adjusted basis of property and recovered through an allowance called depreciation. Exploration and development costs for mining operations are capitalized into the mine and recovered through an allowance called depletion. Thus, capitalized costs with respect to a mine are "of a type" for which depreciation is allowed, even though technically the costs may be recovered through depletion rather than depreciation.

Federal tax law has long recognized the close similarities between depreciation and depletion. Section 167 (which provides the deduction for the allowance for depreciation) cross references section 611 (which provides the deduction for the allowance for depletion) "for additional rule applicable to depreciation of improvements in the case of mines . . ." Section 611(a) itself uses the terms "depletion" and "depreciation" interchangeably when describing the reasonable allowance for the cost recovery of a mine. Treasury regulations section 1.611-5 provides that the depletion deduction related to mine improvements is computed under the depreciation rules of section 167 and allowed under section 611.

Also, as the preamble to the proposed regulations notes, "the depreciation allowance for tangible property applies only to that part of the property which is subject to wear and tear, to decay or decline from natural causes, to exhaustion, and to obsolescence." See Preamble at p. 18. Similarly, cost depletion deductions are intended to measure exhaustion of the mine based on the portion of the estimated natural resource reserve that was produced during the year. Thus, the Supreme Court in several cases has found that the purposes of the depreciation deduction and the depletion deduction are the same. For example, in Parsons v. Smith, 359 U.S. 215 (1959), the Supreme Court stated:

"[The depletion] exclusion is designed to permit a recoupment of the owner's capital investment in the minerals so that when the minerals are exhausted, the owner's capital is unimpaired." Commissioner v. Southwest Exploration Co., 350 U.S. 308, 312. Save for its application only to gross income from mineral deposits and standing timber, the purpose of "the deduction for depletion does not differ from the deduction for depreciation." United States v. Ludey, 274 U.S. at 303. In short, the purpose of the depletion deduction is to permit the owner of a capital interest in mineral in place to make a tax-free recovery of that depleting capital asset.

In summary, the types of property subject to depletion and the purposes (and determination) of depletion deductions are sufficiently similar to the types of property subject to depreciation and the purposes (and determination) of depreciation deductions to warrant the treatment of depletable properties as QBAI under GILTI. It is also consistent with the underlying policy to exclude normal returns on business investment from application of the GILTI minimum tax.

To properly measure the normal return with respect to mineral interests held overseas, we believe a second clarification is necessary. Section 951A(d)(3)(A) provides that the adjusted basis in any property treated as QBAI is determined using the alternative depreciation system under section 168(g). The use of the alternative depreciation system is intended to reflect economic depreciation and more properly measure the diminution of value on such assets. For similar reasons, the adjusted basis in a mine or other natural deposit included as QBAI should be determined using cost depletion, rather than percentage depletion.

Treasury has significant authority to clarify that the capitalized cost of a mine should be taken into account as QBAI, and adjusted by reference to cost depletion. First, it has a general grant of interpretative authority under section 7805 to determine what property is "of a type" to which depreciation is allowed. Second, section 611(a) provides authority to the Secretary to determine reasonable allowances for depreciation and depletion (as those terms are used interchangeably) with respect to mines and other natural deposits. Finally, as described above, the legislative history to section 951A demonstrates that Congress intended to limit application of the GILTI minimum tax to "supernormal returns," and thus Treasury has authority to apply the statute in a manner consistent with its express purpose by using cost depletion to measure properly a taxpayer's normal return on investment.

We greatly appreciate the opportunity to submit these comments for your consideration and would be happy to meet with you to discuss them at your convenience. If you have any questions in the meantime, please call me at (314) 342-7776.

Sincerely yours,

Robert Bruer
Vice President — Tax Planning & Compliance
Peabody Energy
St. Louis, MO

cc:
Brenda Zent
Gary Scanlon
Jason Yen
Lindsay Kitzinger
U.S. Department of the Treasury

Marjorie Rollinson
John Merrick
Jeffrey Mitchell
Leni C. Perkins
Internal Revenue Service